7-day makeover: Rich by next Monday

Can a one-week makeover solve your money problems and put you on the road to prosperity? We believe so. In fact, that’s just what we set out to prove when we hosted a seven-day financial makeover his past summer in Toronto.

The idea for the makeover came out of a long-running debate here at MoneySense. Over the years, we’ve interviewed hundreds of people — some of them financial disasters, others financial superstars. We’ve observed that some people seem incapable of managing their money wisely, while other folks appear to have born with a natural understanding of high finance and probably toddled off to nursery school with compound interest tables under their arms.

Our experience has left us wondering if it’s possible for people to change their financial personality. Can an impulse shopper turn into a bargain hunter? Can a day trader become a disciplined investor? Can a couple that always argues about money find ways to live happily ever after?

MoneySense has always operated on the assumption that the answer to all the above questions is yes — but, in all honesty, we’ve never tried to change people’s lives, then monitor the results. It was only fair, we decided, to put our beliefs to the test. We would go looking for people who were stressed about money. Then we would bring them to Toronto for a week, expose them to some of the brightest financial minds that we know, and see if we could transform these self-confessed financial messes into money masters. Perhaps we would accomplish nothing. Or perhaps we would have the satisfaction of seeing people’s lives take a U-turn for the better as a result of some sage financial advice.

Our great experiment began early this year when we invited people to write us and explain why they needed a financial makeover. The response was enthusiastic. More than 220 people took the time to write us lengthy letters — essays, in some cases — about their financial situations.

Many of your letters touched our hearts. We heard from people with serious medical problems. We heard from single moms who were trying to raise kids on minimum-wage jobs. We heard from people who had made disastrous investments, often as a result of trusting in some supposedly expert advice.

We also got more than a few letters that left us shaking our heads. A handful came from young couples with incomes of $200,000 or more a year who seemed genuinely perplexed about why they couldn’t afford all the toys they would like right away. And, yes, we did get a couple of letters from former financial planners, who had run up large amounts of debt and were wondering if, gee, we might have any insights into how they could get out of their troubles.

Trying to pick winners was agonizing — in part, because we were forced to realize that we had no financial magic to offer people mired in minimum-wage poverty or suffering from devastating medical problems. We have enormous sympathy for people caught in these plights, but their problems are not problems of investing, or tax, or insurance — which is where our very limited expertise lies.

Looking at the other extreme, we had problems with the idea of treating a young couple earning $200,000 to an all-expenses paid week in Toronto, with dollops of financial advice thrown in for free. As much as these affluent couples might need advice on investing, tax and insurance, we figured they could buy it themselves.

In the end, we chose three couples and one single person to take part in the makeover. Our winners came from across Canada and from different age groups. None of them was rich, but they all had enough money to have options. Most important, each of them was stressed about money and each was ripe for change.

We held the makeover in the Fairmont Royal York, a beautiful hotel in the core of downtown Toronto. As we waited for our winners to arrive that morning in June, we gobbled muffins and braced ourselves for the worst. Would our participants be pleasant? Interested in what we had to say? Or just looking for a get-rich-quick scheme?

We shouldn’t have worried. As our seven winners filed into the room and we started talking, we were delighted to discover an amazing fact — we liked each of them a lot. They were bright, engaging people. Oh, and forgiving too. It turned out that three of our participants, all from the West Coast, were on a plane that had been diverted to Hamilton the previous day because of bad weather. They had sat on the tarmac for six hours before finally making it to Toronto. Despite the horrific flight, everybody seemed in good spirits.

That first day each of our participants met with a core group of three financial planners. Norbert Schlenker was the lead adviser and the person who would eventually present each of our winners with a financial plan. We had chosen him for that job because Schlenker is one of the smartest people we know. He holds a master’s degree in computer science from Princeton; he’s also a chartered financial analyst and a certified financial planner, and has spent years working in the financial industry. His firm, Libra Investment Management of Victoria, specializes in offering unbiased advice to wealthy clients, and Schlenker would offer that same unbiased — and sometimes very blunt — advice to our participants.

Our core group of advisers also included Warren MacKenzie of Second Opinion Investor Services of Toronto, and JoAnne Anderson of the MoneyPower Group at Raymond James in Mississauga, Ont. Both are experienced and wise advisers. MacKenzie is a chartered accountant, certified financial planner and the author of The Unbiased Advisor, while Anderson was named Adviser of the Year in 2005 by Advisor’s Edge Report and has impressed us over and over again with her ability to see into the psychology of individuals in financial distress.

Over the course of several days, our winners met with these three advisers, as well as a star-studded lineup of other experts. (For a complete roster of our speakers, see “The advice squad” below) On the final day each of our participants received a personal financial plan. You can read their stories in the rest of this issue and you can follow our winners’ progress on their own blogs, which will debut in September. We hope you’ll visit the blogs frequently to see how our makeover participants come to terms with their money issues over the next few months.

What were the big lessons that we and our winners took away from the makeover? Four crucial points impressed us:

Most people pay way too much for investment advice

Most small investors put their money into what are known as actively managed mutual funds. These are funds run by a manager. The manager invests your savings in the stocks or bonds that he or she thinks have the greatest potential to beat the market.

If this is how you invest your money, you’re probably paying your money manager 2% to 2.5% of your savings in fees. (You can find out the exact amount by looking at your fund’s management expense ratio, or MER.) You pay the fees every year, but they are deducted before your results are calculated, so you never see them. Still, the invisible fees take their toll. On a typical $200,000 RRSP account, you’re shelling out $4,000 to $5,000 a year.

That’s a lot of money — and the amazing thing is that those thousands of dollars in fees don’t buy you any extra performance. Just the opposite, in fact. The vast majority of actively managed funds lag behind the market.

Let us underline that point: you are paying a lot of money for nothing. “There is absolutely no value to investment management,” Schlenker told one of our participants. You can do better than most investors in actively managed mutual funds by investing in a simple assortment of what are known as index funds. These funds don’t try to beat the market. Instead, they aim to keep pace with it. They do this at very low cost — as little as a few hundred bucks a year on that $200,000 account of yours. The thousands of dollars you save every year go directly to your bottom line. (For more on how to build a good low-cost portfolio, see “Be a Couch Potato” or look up “Couch Potato investing.”)

Most people don’t know how to choose an adviser

If advisers can’t help you beat the market, what good are they? According to Schlenker, a good adviser can help you estate planning and tax planning. He or she can also help give you the discipline to stick to an investment program.

Given the limited nature of what an adviser can do, you should carefully assess whether you need one. If you decide that you do need help, be aware that most advisers still operate on the basis that “advice is free.” What most don’t tell you is that they make their living from the large but invisible fees that you pay on the mutual funds and other products they sell you.

A better way to pay advisers is to have them split out their fees so you know exactly how much you’re paying for advice. The most transparent way to do this is to find an adviser who won’t sell you products, but will charge by the hour to tell you what to do.

No matter how you pay your adviser, ask some tough questions. “The financial industry is full of people looking to line their own pockets at your expense,” Anderson told our participants. “As Canadians, we’re very good at not asking questions. But if you want to find a good adviser, you have to probe. Most important, you have to find out how your prospective adviser is being compensated — how they’re going to be making money off you. You should never be afraid to ask an adviser: how much are you making off this product that you’re recommending to me?”

Anderson suggested some other topics to raise with any prospective adviser. “Ask them how long they’ve been in business. Ask them about their professional qualifications. And ask them if you’re the typical type of person they deal with — most advisers specialize in a certain type of client. If you’re an outlier, an unusual case, the adviser is going to have a big learning curve if he or she really wants to give you good advice.”

Most people are doing better than they think thy are

All our participants entered the makeover feeling huge amounts of stress. They were convinced they were falling behind and not doing as well as they should be.

They were delighted to discover they were in much better shape than they thought. In fact, most of our participants were amazed when they learned the average wealth figures for people their age. According to Statistics Canada data, updated by MoneySense, Canadian families headed by a 40-year-old had median net worth of $160,000 in 2008. By the time the primary income earner hits 50, that figure rises to $265,000 and at 60, it bumps up to $450,000. Yes, the net worth figure spans both husband and wife. It includes real estate, RRSPs, pension plans, investment portfolios and money in the bank. So you don’t have to have a million bucks to be doing better than average. Far from it.

And the news gets better, because many people ignore the wealth they’ve accumulated in their pension funds at work. Especially if you’re in your fifties, your company pension could be your largest asset. You can find out the current value of your pension by asking your human resources department. Yet many of us — including some participants in the makeover — ignore that asset when we’re fretting about how little we’ve saved.

Most people overestimate the cost of retirement

Malcolm Hamilton, a consulting actuary at Mercer, a Toronto benefits consulting firm, gave our participants a dazzling presentation on the realities of building wealth in Canada. His key finding? A typical Canadian couple who are working and raising kids actually has less money to spend on themselves than the typical senior couple. While many of our participants had worried about saving for retirement, the reality is that they are likely to have more cash in their wallet at 65 than they do now. With no more child-rearing expenses to cover, or mortgage payments to make, they will probably live better in retirement than they do now.

Hamilton offered some simple life lessons. First and foremost, repay your debts. Then diversify your investments and keep your investment expenses low. Paying even 2%-a-year in fees will consume one third of your retirement savings over time, Hamilton noted, so try to keep your costs substantially below that figure.

Other tips? Don’t be afraid to invest in yourself or your kids, but be prepared to roll with the punches — life has plenty of surprises, both good and bad. A habit of frugality is always good, but savings may not be: you don’t want to live in poverty today simply to squirrel away money for some distant future that may never come. Finally, said Hamilton, “Make sure you understand what you’re investing in. If you don’t understand an investment, you’re probably not the one getting rich.” We couldn’t agree more.